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Who Wants a 30-Year Mortgage?

AS we all move forward with our New Year’s resolutions, it’s a good time to remember the promises our politicians have been making about the American mortgage market. The Obama administration, at a conference last August on the future of housing finance, pledged to have, come January, a plan for Fannie Mae and Freddie Mac, the mortgage giants that are now wards of the government. Congressional Republicans, in their recent position paper, made an even bolder resolution: to build a mortgage market that “does not rely on government guarantees” and “does not make private investors and creditors wealthy while saddling taxpayers with losses.”

This latter promise is pleasing populist rhetoric. The problem is, it may be neither politically nor practically feasible. Even if we forget about the gigantic near-term problem — namely, that the federal government is in the housing market mainly because most banks simply won’t issue mortgages that can’t be guaranteed by Fannie, Freddie or the Federal Housing Administration — there’s the fact that federal involvement in housing has been a constant since the 1930s. A market without government support would almost certainly involve the demise (for most of middle-class America) of that populist favorite, the low-cost 30-year fixed-rate mortgage.

For a homeowner, a mortgage with a 30-year fixed rate (especially one that he can pay off early without a penalty) is a wonderful thing. For lenders and investors, however, it is a financial Frankenstein’s monster, an unnatural product filled with the potential for losses. Absorbing some of the risk of those losses is a large part of what the government does in the housing market.

Fannie Mae and Freddie Mac, for instance, were created by the federal government to buy up mortgages from lenders, thereby enabling them to turn around and issue more mortgages. Among other things, this allowed the lenders to get off their books the two kinds of risk that a mortgage carries. We’re all now sadly familiar with one kind, credit risk — that is, the danger that a borrower won’t pay back the mortgage. The second is interest-rate risk, the danger that interest rates will rise sharply after the mortgage has been made, thereby burdening the bank with money-losing loans. (Interest-rate risk was the root cause of the savings and loan crisis.) The longer a mortgage lasts, the more difficult it is to manage both of these risks. And 30 years is an awfully long time.

With the advent of securitization, or the ability to package up mortgages and sell them off as securities, the market found some investors — bond funds, insurance companies and others — that were willing to take on interest-rate risk. But even in those halcyon days when credit risk wasn’t supposed to be an issue, the majority of investors still didn’t want it. So Fannie and Freddie solved the problem by guaranteeing the payment on mortgages before the securities were sold off to investors. (In the non-government market, the ratings agencies provided a solution, by stamping large pieces of securitizations with the supposedly ultrasafe triple-A rating.)

Today, credit risk is anathema, and by shouldering it, Fannie and Freddie are propping up the housing market. The banks that make the mortgages don’t want credit risk, and neither do investors. Indeed, William Gross, the co-founder and managing director of the investment firm Pimco, has said his funds wouldn’t buy pools of so-called private label mortgages — those lacking a government guarantee — unless the homeowners involved had made a down payment of at least 30 percent.

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The proposed Fannie-Freddie reform that has gotten the most traction recently — various iterations of this have been endorsed by Hank Paulson, the former Treasury secretary, among others — calls for new private-sector entities that would continue to provide credit guarantees on mortgages. These guarantees would not be entirely private, however, because they would be explicitly backed by the full faith and credit of the United States.

There are various proposals for how this could be done with less risk to taxpayers than Fannie and Freddie pose, but, obviously, we’re still talking government involvement. And there’s something perverse about creating companies that would be saddled with exactly the same kind of risk — credit risk — that took down Fannie and Freddie in 2008. Furthermore, we’re kidding ourselves if we don’t think that once the memory of the housing bubble begins to fade, these new creatures won’t find themselves under political pressure to keep the price of their credit guarantees low, in order to help keep the price of the 30-year mortgage low as well.

Wouldn’t a better solution be for banks and other financial institutions to offer mortgage products that they actually want to keep on their own books? Maybe these would take the form of 15-year mortgages with a rate that would be adjusted after five years so that the banks wouldn’t have to worry about long-term interest-rate risk. This might not even mean the disappearance of 30-year fixed-rate mortgages — the private market has historically provided them to consumers whose mortgages are too big to qualify for a Fannie and Freddie guarantee. But these are usually issued only to the wealthiest, most credit-worthy consumers.

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And therein lies the rub. Almost certainly, any 30-year product would be offered on a more limited basis and at a higher price than it is today. How much higher, it’s hard to say. In the pre-crisis days, Fannie used to argue that its guarantee enabled consumers to pay one quarter to one half of a percentage point less in annual interest on their mortgages; today, Mr. Gross says that mortgages without a government guarantee would cost at least several percentage points more. If his numbers are right, then mortgages — and 30-year mortgages in particular — would be far more expensive, and the pool of American homebuyers would shrink.

This may well be the right long-term answer. After all, other countries manage fine without the widespread availability of 30-year fixed-rate mortgages. But is there an American politician alive who would accept responsibility for depressing the housing market further?

In any case, even a willingness to have more expensive mortgages would not get the government out of the housing market completely. Recall that, before the bubble burst in 2007, the private sector didn’t do much better than the government-sponsored entities at monitoring mortgage risk. What would happen years down the road if one of our increasingly large banks, one that is critical to the mortgage business, ran into trouble? Even assuming that we’d solved the issue of allowing such banks to be too big to fail, there’d still be deposit insurance. Taxpayers would still be on the hook.

So be wary of politicians bearing promises of a perfect world where average Americans can get the mortgages to which we now all feel entitled and the government is nowhere to be seen. It’s a mirage.

Bethany McLean is the co-author, with Joe Nocera of The Times, of “All the Devils Are Here: The Hidden History of the Financial Crisis.”

A version of this op-ed appears in print on January 6, 2011, on Page A27 of the New York edition with the headline: Who Wants a 30-Year Mortgage?. Today's Paper|Subscribe